XMFSinchiruna (26.96)

Fed Announces it will Print as Much Money as Necessary

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As I peruse the news, I can't believe just how many incredible events are being revealed to the population all at once, with no chance that an average Joe can track nor even understand the true scope or severity of the situation. I placed a few of the more amazing portions of this NYT article in bold to make the point. We ... are in trouble here.

WASHINGTON — The Federal Reserve entered a new era on Tuesday, lowering its benchmark interest rate virtually to zero and declaring that it would now fight the recession by pumping out vast amounts of money to businesses and consumers through an expanding array of new lending programs.

Going further than expected, the central bank cut its target for the overnight federal funds rate to a range of zero to 0.25 percent and brought the United States to the zero-rate policies that Japan used for years in its own fight against deflation.

Though important as a historic milestone, the move to an interest rate of zero from 1 percent is largely symbolic. The funds rate, which affects what banks charge for lending their reserves to each other, had already fallen to nearly zero in recent days because banks have been so reluctant to do business.

Of much greater practical importance, the Fed bluntly announced that it would print as much money as necessary to revive the frozen credit markets and fight what is shaping up as the nation’s worst economic downturn since World War II.

In effect, the Fed is stepping in as a substitute for banks and other lenders and acting more like a bank itself. “The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth,” it said. Those tools include buying “large quantities” of mortgage-related bonds, longer-term Treasury bonds, corporate debt and even consumer loans.

The move came as President-elect Barack Obama summoned his economic team to a four-hour meeting in Chicago to map out plans for an enormous economic stimulus measure that could cost anywhere from $600 billion to $1 trillion over the next two years.

The two huge economic stimulus programs, one from the Fed and one from the White House and Congress, set the stage for a powerful but potentially risky partnership between Mr. Obama and the Fed’s Republican chairman, Ben S. Bernanke.

“We are running out of the traditional ammunition that’s used in a recession, which is to lower interest rates,” Mr. Obama said at a news conference Tuesday. “It is critical that the other branches of government step up, and that’s why the economic recovery plan is so essential.”

Financial markets were electrified by the Fed action. The Dow Jones industrial average jumped 4.2 percent, or 359.61 points, to close at 8,924.14.

Investors rushed to buy long-term Treasury bonds. Yields on 10-year Treasuries, which have traditionally served as a guide for mortgage rates, plunged immediately after the announcement to 2.26 percent, their lowest level in decades, from 2.51 percent earlier in the day.

Yields on investment-grade corporate bonds edged down to 7.215 percent on Tuesday, from 7.355 on Monday. Yields on riskier high-yielding corporate bonds remained in the stratosphere at 22.493 percent, almost unchanged from 22.732 on Monday.

By contrast, the dollar dropped sharply against the euro and other major currencies for the second consecutive day — a sign that currency markets were nervous about a flood of newly printed dollars. Some analysts predict that the Treasury will have to sell $2 trillion worth of new securities over the next year to finance its existing budget deficit, a new stimulus program and to refinance about $600 billion worth of maturing government debt.

For the moment, Mr. Obama and Mr. Bernanke appear to be on the same page, though that could abruptly change if the economy starts to revive. Fed officials have already assumed that Congress will pass a major spending program to stimulate the economy, and they are counting on it to contribute to economic growth next year.

In more normal times, the Fed might easily start raising interest rates in reaction to a huge new spending program, out of concern about rising inflation.

But data on Tuesday provided new evidence that the biggest threat to prices right now was not inflation but deflation.

The federal government reported on Tuesday that the Consumer Price Index fell 1.7 percent in November, the steepest monthly drop since the government began tracking prices in 1947. The decline was largely driven by the recent plunge in energy prices, but even the so-called core inflation rate, which excludes the volatile food and energy sectors, was essentially zero.

Mr. Obama’s goal is to have a package ready when the new Congress convenes on Jan. 6. His hope is that the House and Senate, with their bigger Democratic majorities, can agree quickly on a plan for Mr. Obama to sign into law soon after he is sworn into office two weeks later.

The Fed, in a statement accompanying its rate decision, acknowledged that the recession was more severe than officials had thought at their last meeting in October.

“Labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment and industrial production have declined.”

The central bank added: “The committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.”

With fewer than 10 days until Christmas, retailers from Saks Fifth Avenue to Wal-Mart have been slashing prices to draw in consumers, who have sharply reduced their spending over the last six months. On Tuesday, Banana Republic offered customers $50 off on any purchases that total $125. The clothing retailer DKNY offered customers $50 off any purchase totaling $250.

Ian Shepherdson, an analyst at High Frequency Economics, said falling energy prices were likely to bring the year-over-year rate of inflation to below zero in January.

The Fed has already announced or outlined a range of unorthodox new tools that it can use to keep stimulating the economy once the federal funds rate effectively reaches zero. On Tuesday, Fed officials said they stood ready to expand them or create new ones to relieve bottlenecks in the credit markets.

All of the tools involve borrowing by the Fed, which amounts to printing money in vast new quantities, a process the Fed has already started. Since September, the Fed’s balance sheet has ballooned from about $900 billion to more than $2 trillion as it has created money and lent it out. As soon as the Fed completes its plans to buy mortgage-backed debt and consumer debt, the balance sheet will be up to about $3 trillion.

“At some point, and without knowing the timing, the Fed is going to have to destroy all that money it is creating,” said Alan Blinder, a professor of economics at Princeton and a former vice chairman of the Federal Reserve.

“Right now, the crisis is created by the huge demand by banks for hoarding cash. The Fed is providing cash, and the banks want to hoard it. When things start returning to normal, the banks will want to start lending it out. If that much money is left in the monetary base, it would be extremely inflationary.”

Or here's a real classis buried in a story about Obama's stimulus plan:

"While some economists consulted by Obama's team recommended spending of up to $1 trillion over two years, a more likely figure seems to be $850 billion. There is concern that a package that looks too large could worry financial markets, and the incoming economic team also wants to signal fiscal restraint."

I wish we had emoticons in CAPS blogs, because there are several I'd like to paste after that text! Fiscal restraint? Is that not worth at least a sardonic laugh?

I'm of the opinion that deflation is here to stay for at least several quarters... then hyperinflation once Obama's stimulus works its way through the system... but I'm no economist... What do you all think?

I see no way to predict the timing, since so many factors are at play. My sense is that the transition will take place sooner as foreign entities unload our dollar and kick-start price inflation in that way.

Either way, with deflation or inflation, we are in for the ride of a century over the coming year, IMO. Dow 5,000 would not surprise me one bit, and eventually Dow at parity or near parity with an ounce of gold.

Freund... I'm glad my posts and articles are helpful! I'm just thankful to be witnessing these events as they unfold in the company of a great community of people here in CAPS! :)

What really ticks me off is that no one seems to realize that deflation is GOOD for the economy. YOU HEAR ME!?! ITS GOOD. Prices have been rising too fast and have been too high for too long. With stagnant wages for the last 15 years, it left most Americans with very little disposable income (% wise) so all our spending was based on credit. But now we can spend REAL MONEY! Are you HEARING ME OUT THERE?!? REAL MONEY is GOOD for the economy! Goooood!!!!! Say it with me now, real money is good!!

Scary stuff... and outoffocus, that's what's bugging me a lot lately... isn't some deflation exactly what we need? All that panicking after 1 month of data recently... and then all I could think was, hmm, but consumer prices were so high year-over-year, and they've been horribly high and you're right, that's part of why so many people did need to rely on credit, that's a really good point. I believe I read Murray Rothbard argued that deflation to some degree and for a certain amount of time IS good (maybe not for too terribly long, but not grounds for immediate panic), and of course panic over deflation, isn't that what led to the Greenspan cuts contributing to our problems now? And gosh, well too bad it's horrible for debtors, we are in loads of trouble with debt. I don't know, I'm not an economist and I haven't studied into this nearly enough, but I am concerned panicky reaction to the deflation boogeyman is going to be the downfall... oh well my two cents, I'm rambling. ;)

The U.S. gov't can always print more dollars (i.e. Treasury securities), and the U.S. gov't is the biggest debtor in the history of the world... and going further into debt is what pays for the vote-buying of the decision makers. GMX is frequently right about what happens in the next week or two, but I'm with Chris (Sinch): load up on gold and silver, especially SLW, because we're going to print enough dollars to make deflation worry a fond memory.

I may not be an economist but I am an accountant. That means I understand BALANCE SHEETS. Having so many balance sheets in the red CANT be good for our economy (you hear me GM?). Back in the day when we had common sense, when you audited a company with a bad balance sheet, you were supposed to disclose in the audit report whether or not you thought the company was a going concern. Now I'm just concerned where they are going. You have a large corp with a bad balance sheet going to a government with a bad balance sheet asking for a bailout. Am I the only one seeing the total insanity in that logic?

I agree deflation could be good. The problem is once it starts deflation is almost impossible to control/stop. The mentality is why buy to day when next month/year it will be cheaper.

I think we are in an asset deflationary period for at least another year. (housing and real estate go down) And after the year or so inflation. Now the worst case is asset deflation and consumer inflations. The kicker in all of this is GDP growth will most likely be negative as we hit the inflation period so we are in for a lot of trouble.